This refers to measurable factors of economic performance that shifts ahead of the economic cycle before it begins to follow a specific pattern. As a measure of economic performance, it is used to predict shifts in economic activity. What you need to know is that they (leading indicators) are not always accurate.
According to financial experts, these statistics have been found to precede by one to 12 months. As short term predictors, they help to predict and make sense in regards to the direction taken by the economy.
That is why investors use a leading indicator to formulate and adjust their strategies with the purpose of benefiting from future market conditions. On the other hand, policy makers keep an eye on these measurable factors of economic performance to aid in adjusting monetary policy.
Businesses people are not left behind either. Since changes to the economy affect the profitability of a business, a leading indicator allows business owners to anticipate upcoming economic changes.
As said earlier, a leading indicator is not usually accurate and that is why it is combined with data from other sources in order to reveal trends that result in economic changes.
Examples of leading indicators
a. Consumer confidence
b. Managers purchasing index
c. Supply of money
d. Bond yields
e. New business start-ups
Consumer Confidence Index (CCI)
CCI refers to a monthly release produced by the Conference Board. Conference Board is a non-profit business group regarded highly by investors and the Federal Reserve. As a unique indicator, it is formed from survey results collected from over 5,000 households.
The report is usually designed to show relative financial health, spending power and average consumer confidence. CCI plays an important role especially when it comes to securities trading.
For example a strong CCI report can motivate investors to purchase more securities even though the economy is lagging behind.
Managers Purchasing Index
As one of the leading indicators, purchase of capital goods has been found to be an important barometer of the business cycle. Not only does it affirm confidence when it comes to future demand, it will help to improve economic activity.
In case of a looming recession, you will note that firms will start to cut back on capital purchases. That is why the managers purchase index is an important economic indicator.
The Institute for Supply Management, a non-profit group that boasts 40,000+ members maintains the Purchase managers Index.
Money supply refers to the amount of money floating in the economy and is available for spending by the masses. As another economic indicator, the Federal Reserve has placed a measure of control over the supply of money.
This measure is implemented through open market operations where buying and selling of treasuries plus the setting of the reserve requirements happens.
The Federal Reserve achieves this by setting short term interest rates which help to guide the economy. The good thing about this indicator is that it is timely and consistent. Furthermore, it creates opportunities for those who know how to utilize it.
This refers to the amount of return that an investor realizes from a bond. Since the purchase of bonds by investors results in the lending of money to bond issuers, they (bond issuers) agree to pay an interest. This occurs throughout the lifetime of the bond. The amount of money investors earn is referred to as yield.
When economic conditions push markets to safer investments, the investor’s yield will fall. Factors affecting the decline in yields include high rate of unemployment, slow economic growth or recession. When interest rates increase, the prices of bonds usually falls.
New business start-ups
According to financial experts, the rise in new business start-ups helps to indicate the health of the economy. Why? It has been noted that new businesses hire more employees than larger companies which helps to address the problem of unemployment.
Furthermore, new business start ups contribute immensely to the GDP as they introduce innovative ideas and products which help to stimulate economic growth.
While it can be difficult for experts to know the exact state of the economy, using leading indicators can act as a guide for future trends.
Common economic measures include Consumer Confidence Index, Managers Purchasing index, Money Supply, Bond Yields and New business start-ups.